Berkshire to welcome new shareholders at annual meeting

AlistairBarr

SAN FRANCISCO (MarketWatch) -- When Berkshire Hathaway Inc. bought railroad operator Burlington Northern Santa Fe in February, it got at least 65,000 new shareholders, swelling the ranks of one of the most loyal shareholder groups in the world to more than 550,000.

Some of these investors are headed to Omaha, Neb. this weekend for their first Berkshire annual meeting. Attendance this year will likely be higher than in 2009, when a record 35,000 or so turned up to get advice from Chairman Warren Buffett in the wake of the worst financial crisis since the Great Depression.

Burlington will be a major focus for investors during the meeting. The $26 billion deal didn't just change Berkshire's investor base. It also marked the biggest step in a transformation of the company that began at least two decades ago.

Berkshire used to be a vehicle for Buffett's stock picking -- a bit like a closed-end investment fund. Now it's more like a conglomerate, along the lines of General Electric Co.
GE, -0.14%

Some investors reckon the transformation will help reduce risks when Buffett, aged 79, stops running Berkshire
BRK.A, -0.53%BRK.B, -0.48%
and passes the reins to new managers.

"From a quasi estate-planning point of view, Berkshire's affairs are much more in order than they were two or three years ago," said Thomas Russo, a partner at Lancaster, Penn.-based Gardner Russo & Gardner, which owns Berkshire shares.

Berkshire had more than $44 billion in cash in 2007, Russo said.

"This assumed that the new person deploying that money was going to do it as well as Warren could. That was a concern for shareholders," Russo said. "A lot of that cash has now been deployed by Warren, so that risk is reduced."

Including the money used to buy Burlington, Berkshire probably has $22.6 billion in cash now, according to a recent estimate by Jay Gelb, an insurance analyst at Barclays Capital. That's the lowest level in many years and is pushing up against Berkshire's internal minimum requirement of $20 billion, the analyst said.

Berkshire generates prodigious free cash flow -- churning out $11 billion in 2009. But in future, a big chunk of that money will be used by Burlington Northern and MidAmerican, a giant utility business the company also owns.

For most of his career, Buffett shunned such capital-intensive businesses, preferring companies that generate higher returns on capital and need little new money to grow.

However, Berkshire's cash hoard grew so large that Buffett became willing to own businesses that soak up some of this money -- even if it meant lower returns than in the past.

"We are today quite willing to enter businesses that regularly require large capital expenditure," Buffett wrote in his letter to shareholders this year. "We expect only that these businesses have reasonable expectations of earning decent returns on the incremental sums they invest."

Burlington shares some "important economic characteristics" with Berkshire's utilities business, he said, while adding that the railroad operator's results will be lumped in with those of MidAmerican in future earnings reports.

"Both will require heavy investment," he warned. But Buffett also said that demand for their products and services will be strong in the future, suggesting steady returns are possible.

Berkshire's insurance businesses, which give Buffett billions of dollars to invest in the stock and bond markets, used to generate most of the company's profit. In 1995, they contributed three-quarters of total earnings, while Berkshire's manufacturing, publishing and retail businesses made up most of the rest.

By last year, Berkshire's non-insurance businesses accounted for half of the company's profit. These range from manufacturers like Iscar to furniture retailers, food distributors and apparel makers.

The addition of Burlington will likely add at least another $2 billion of earnings a year, increasing the importance of this part of the company, according to Gelb's estimates.

"In the first decade of Buffett's control of Berkshire, the company's growth was driven more by his prowess as an investor," Justin Fuller, a partner at Midway Capital Research & Management LLC, wrote in a recent post on his Web site buffettologist.com.

It wasn't until the mid-1980's that earnings from Berkshire's wholly owned businesses became important, he said.

"Over the ensuing years, this earnings stream has become a bigger and bigger component of Berkshire's net worth," Fuller wrote.

When Berkshire acquires companies, Buffett leaves executives running the businesses. So as this part of the company grows, there will be less money left over to invest in stock and bond markets.

This is important as Buffett prepares to step down. His departure may not be imminent, but he's made detailed preparations for succession.

Buffett's job will be split in two. One executive will become CEO, responsible for operations. Another one, two or even three executives will oversee investments.

David Sokol, head of the MidAmerican utility business, is considered the top candidate for CEO, while candidates for the investment job are less clear.

With Burlington and MidAmerican soaking up billions of dollars each year, the investment job will likely be less taxing than it used to be.

"I've heard the theory that he bought Burlington to use up enormous amounts of capital so that his successor won't have to worry about allocating too much when he steps down," said Whitney Tilson, head of hedge-fund firm T2 Partners LLC and a Berkshire investor.

Still, Tilson doesn't buy the theory.

"I think Buffett would chuckle at the idea," Tilson said. "Buffett is a purely economically rational person. The shift in his approach from picking stocks to buying companies is driven by other things."

One reason for the shift is Berkshire's size. The company is so big now that only acquisitions of large companies move the needle, Tilson said.

Another reason is that Buffett has sometimes been disappointed after buying non-controlling stakes in public companies, Tilson and Russo said.

Some companies that Buffett invested in have pursued expensive acquisitions that dented future returns. Russo cited Gillette's acquisition of Duracell as an example.

A more recent one was Kraft's
KFT
acquisition of Cadbury. Buffett, as a major Kraft shareholder, protested loudly against the deal, but Chief Executive Irene Rosenfeld went ahead anyway. See full story on Kraft-Cadbury deal.

"The lesson that public company managers do dumb things at the expense of shareholders is a lesson that Buffett has taken to heart," Russo said.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.